Bond Variance Risk Premiums
London School of Economics & Political Science (LSE) - Department of Finance
London School of Economics and Political Science
Department of International Business, National Chengchi University
September 27, 2013
This paper studies variance risk premiums in the Treasury market. We introduce and price the generalized Treasury variance swap that takes into account stochastic interest rates, is robust to jumps and can be perfectly replicated by a static position in Treasury futures options and a dynamic position in the underlying sampled at the daily frequency. We document that shorting the variance swap yields positive returns with annualized Sharpe ratios around two that cannot be explained by standard risk factors. The term-structure of implied variances is downward sloping but increasing in tenors and its slope is strongly linked to economic activity.
Number of Pages in PDF File: 61
Keywords: Variance risk premium, Treasury implied volatility, Variance swap
JEL Classification: E43, G12
Date posted: January 2, 2012 ; Last revised: September 28, 2013
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